Commentary: The "Oil Conundrum" of 2016

Photo by Randy Stern
Photo by Randy Stern

Have you ever wondered why fuel prices can spike by over 20 cents overnight?

The answer to that question is extremely complicated, but in the simplest terms it comes down to one word: speculation. Speculation drives oil prices as well as the long term production plans of automakers. Oil prices are only partially connected to the physical world and current events can embolden or scare speculators to drastically change the price of oil in the short term.

Oil production has been at an all time high and it doesn't seem like OPEC or Russia wants to change that. The Brent Crude price of oil is currently $32.18 a barrel. Compare that to a peak price of $126.65 a barrel in April 2008, and you can see just how far prices have fallen. According to the U.S. Energy Information Agency the average price of regular unleaded is $1.72 per gallon. The last time Americans saw prices this low it was in December 2008. Americans began to rethink their love affair with large vehicles when fuel prices spiked, but with a gallon of gasoline cheaper than a gallon of milk that love affair is coming back stronger than ever.

SUVs and their more car-like crossover brethren are more popular than ever. Ford Motor Company believes that the world automotive market will be 40 percent utility vehicle. SUVs are in high demand from South America to China. Automakers are scrambling to try and meet this demand. This demand can be traced back to one thing and one thing only. The world economy is gorging itself on cheap fuel.

The largest and most profitable vehicles that automakers build are more fuel efficient than ever thanks to advancements in engine technology such as turbocharging and downsizing.. Low fuel prices imbue consumers with more confidence and helps cloud memories of fuel price volatility that came with the financial scare of 2008. Ford Motor Company and Fiat Chrysler Automobiles are hopeful that these low fuel prices are here to stay.

A deal between OPEC and Russia to freeze production to reduce the oil supply that is outstripping demand all over the world. The Economist spoke in January of an "oil conundrum" where much of the current oil reserves are considered unburnable because of new climate regulations. That means that we currently have more oil than we could possibly use if we want to keep global warming below the threshold of a 2 degrees Celsius increase as compared to pre-industrial levels. If Saudi Arabia and Russia continue to produce they are simply flooding the market with oil that cannot be used. This might suggest that cheap oil is here to stay.

Sergio Marchionne seems to believe that this assessment might be correct. FCA wants to do away with its mid-sized Chrysler 200 and compact Dodge Dart to focus on selling more SUVs and Trucks. This could also be a sign of a weakening FCA whose profits fell 40 percent in 2015. FCA is the most troubled automaker currently and Marchionne is looking to merge with another automaker to stay afloat.

Ford Motor Company also believes that fuel prices will remain cheap, and SUVs will continue to eat up an increasing share of the automotive marketplace. In response to this Ford will launch four new SUVs in the next four years. Ford has had strong sales of SUVs and this is a much stronger sign that there could be a large increase in the number and types of SUVs on the road in the coming years.

On the other end of the spectrum is Honda, who recently released the tenth generation of their Civic. Before the launch of the Civic, the CR-V was the best selling model. As of January of 2016, the Civic is the one flying off dealer's lots above the CR-V and Accord. Because of this and similar sales figures stories, it might be too early to suggest that low fuel prices have destroyed the desire of consumers to choose fuel efficient sedans and hatchbacks.

Low fuel prices might have automakers making different choices, but the need to reach 54.5 MPG fleet wide average fuel economy by 2025. Now automakers are speaking out in hopes to relax these standards because the technological developments needed to meet these standards are proving too harmful to profitability. Whether or not fuel efficiency and emissions compliance is unprofitable it is unlikely that the government will relax their expectations by that much.

This is an interesting time for the automotive industry because efficiency gains and climate regulations have led to a new era of cheap fuel. Despite the low prices there is still the reality of civil uprising in Yemen, Bahrain and Syria. There is also the huge oil reserves of Iran just waiting to seep into the open market. This new reality will weed out the strong automakers from the weak. If fuel prices stay low it will reshape where and how cars will be built. Consumers will be the true winners in all of this. Long term cheap fuel and mandatory efficiency gains will lead to more miles driven on less fuel, more work done on the same gallon of fuel and some well needed reprieve from high monthly fuel budgets.

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